Targeting Growth, Managing Volatility

OCEAN CITY — These are still challenging times for investors. Despite a broad rally in equities, trouble spots remain as a result of sluggish economic growth in the U.S. and major geopolitical issues overseas.

This kind of economic and market uncertainty poses big challenges for those investors who identify opportunities but don’t know the right way to tap into their potential. How do you seize on the highs of precious metals or the Asian consumer’s current strong appetite for technology, for example, while trying to manage potential pitfalls like worldwide inflation and an irregular recovery? Or how do you gain exposure to a specific region of the world with an appropriate level of diversification?

Exchange-traded funds, or ETFs, can help provide targeted access to market opportunities in the U.S. and around the world while mitigating some of the uncertainty built into today’s market environment. In their simplest form, ETFs are baskets of securities that replicate a stock market index or capture select companies of a particular sector. They allow investors to target a particular niche — for example, the stocks of consumer goods manufacturers, which may stand to benefit if the recovery continues to gain momentum.

With ETFs, says Paul Ricciardelli, director, Investment Management & Guidance at Merrill Lynch, “it’s easy to manage broad exposure to an asset class or a sector.” In Merrill Lynch’s multiple-manager mutual funds portfolio, Ricciardelli explains, “we use ETFs to gain an industry-specific or focused play such as gold or commodities. We can pinpoint specific outcomes or increase a specific exposure.”

ETFs are similar to index mutual funds in many ways, but there are key differences. For starters, they typically have lower administrative costs and, therefore, lower fees. Plus, they may offer some tax benefits. For example, a mutual fund may have to sell certain assets — and potentially generate taxable capital gains — when some of its interest holders redeem their shares. Those capital gains are then allocated to the remaining fund interest holders. In contrast, for various reasons, ETFs need to sell their underlying assets less frequently, and thus less capital gain is allocated to their shareholders.

Because ETFs, on the whole, are “passively managed” — meaning that the funds’ investments aren’t selectively chosen but mirror an index — they can be well suited for today’s volatile markets. In such markets, stock prices often move in lockstep, responding in unison to global events. ETFs let you pick a theme or a trend, whether it’s precious metals or Latin American agriculture or tech exporters, and approach it more broadly.

If you believe in the promise of silver, for instance, there’s an entire menu of ETFs you may want to look at: There are precious-metal ETFs, ETFs that mirror the stock indexes of mining-dependent nations, global mining ETFs — even ETFs for single nations (such as Peru) that have mining-dependent economies. Richard Messina, managing director and head of Exchange-Traded Products, Global Investment Solutions at Bank of America Merrill Lynch, says, “ETFs tend to provide opportunities for exposure in multiple markets and relatively low costs, and they can help an investor manage risk.”

ETFs can also provide access to asset classes that are difficult for smaller investors to access — such as currencies and commodities, two sectors that present important opportunities today.

Currency movements often offer a hedge, or a haven, when stock and bond markets decline in tandem. ETFs offer a way to capitalize on the dollar’s performance against other global currencies, a prominent investment theme recently, with the dollar being pushed lower by concern over deficit spending and recent U.S. economic troubles.

What’s more, investing in ETFs is generally less expensive and simpler than trading currency, currency-related instruments or currency derivatives.

Certainly, ETF investing comes with important caveats. You should invest in ETFs big enough or traded widely enough to offer liquidity whenever you want to sell your shares.

In the end, the diversity and flexibility of ETFs may appeal to a broad range of investors with different goals and expectations —and different levels of risk tolerance. Whatever your specific objectives, your financial advisor can help you identify areas in your portfolio that might benefit from ETFs.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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